Notes – The Snowball, By Alice Schroeder: Part II, Chap. 5-19

In a letter to a family member from one of Warren Buffett’s ancestors, Zebulon, the elder Buffett counsels his grandson to

be content with moderate gains

almost as if some strain of value investing ethic permeated his lineage from before Buffett himself had even heard of The Intelligent Investor. Buffett’s family represents a long line of business minded people. Yet, despite this heritage,

Buffett always credited most of his success to luck

It’s an odd, likely guilt-laden existential belief to carry around with oneself! But it is maybe no surprise. Love doesn’t sound like it was given much attention in Buffett’s childhood home, and self-love is probably included, as we learn that:

Politics, money and philosophy were acceptable topics for dinner-table discussion at the Buffett house, but feelings were not. Nobody in the Buffett household said “I love you,” and nobody tucked the children into bed with a kiss.

Any guess as to where some of Buffett’s later self-hating charitable giving ideas might have come from?

If you guessed his psychotic, clinically depressed mother, you answered correctly!

It is Buffett’s relationship to his mother and his vulnerability to her rage as a child that we actually see Buffett in the most sympathetic light. We see as Warren recounts his relationship with his mother this grown, aged man “weeping helplessly”, and we also learn that despite the savage treatment from his mother, which his idolized father was aware of, Howard “didn’t intervene.”

The most vulnerable people in any society are children– they’re physically, intellectually AND emotionally unequipped to make sense of and thoughtfully respond to the irrationalities and volatilities of unstable and violent adults. It is actually quite touching imagining this young, budding genius, Warren Buffett, suffering at the hands of his psychologically diseased mother and developing a precarious existential belief system that leaves him feeling so guilty for the remainder of his life that after all he has (legitimately) achieved, he is still convinced it was mostly due to luck! What an absolute tragedy of human imagination! It would be nice to imagine the poor, hurting and timid child inside of Warren Buffett eventually being freed to go on his way and let Warren wrestle with these childhood demons no more.

What a different world it would be if Warren was a hero entrepreneur rather than a man so tormented by his past that he carries his fears and anxieties into his public persona and recommendations for society at large!

We also see in this information the source of Warren’s fascination with other people’s mothers (who he often developed crushes on), with motherly women in general and with his tendency to have a cadre of close female friends in both his personal and professional life, all while simultaneously having a troubled and distant relationship with his own wife and children later on. What a sad development for an otherwise triumphant individual.

The search for a system – Buffett the handicapper

One of the central themes of Part II is the young Warren Buffett’s search for a “system”: a predictable, confined process for predicting and handicapping the odds of various events in his life. Starting with his bathtub marble race, extending to the racing track (horses) and eventually culminating in his quest for an investment system (part of his initial attraction to Graham, who was especially formulaic, scientific and systematic in his approach to the investment question in general).

And a system, once found, is only valuable if it has a lot of information to process:

There were opportunities to calculate odds everywhere. The key was to collect information, as much information as you could find.

We also begin to see hints of the later, “original” Buffett, with his love of monopoly as a competitive advantage. The anecdotes of Buffett and his friend Russ collecting license plate information in the hopes of eventually providing it to the police to catch a bank robber are examples of Buffett’s early obsession with the value of a monopoly. Similarly, while the young Warren was holed up in a hospital with an illness, he took to collecting the fingerprints of the nurses so that if one of them committed a crime,

he, Warren Buffett, would own the clues to the culprit’s identity

This is a pretty astounding conclusion for a young child to reach, even if it is innocently done. It appears Warren had something of an intuitive understanding of the value of a restricted supply granted by a monopoly on a particular resource.

He also was perplexed by the way so much valuable information (valuable to someone with a system in place for interpreting and analyzing it) went uncollected and unused. An early example is Buffett’s collecting of bottle caps nearby soda dispensers:

The numbers told him which soft drinks were most popular

Do you see the future investor in Coca-Cola beginning to formulate his understanding of the value of consumer habits and patterns?

In the 1940s, Buffett started visiting horse racing tracks where he learned

The art of handicapping is based on information. The key was having more information than the other guy

Buffett ended up reading HUNDREDS of books on horse handicapping before he eventually learned the Rules of the Racetrack:

Nobody ever goes home after the first race

You don’t have to make it back the way you lost it

Buffett later connected these experiences to his investing and understood

The market is a racetrack too. The less sophisticated the track, the better… the trick, of course, is to be in a group where practically no one is analytical and you have a lot of data

In this way, a handicapper or investor can develop informational asymmetries which grant him the all-important edge. Interestingly, Buffett earned a college scholarship in just this way, as he was the only person to show up to a scholarship committee session and thus earned the scholarship by default because he had no competition.

This is where the quote about Buffett sifting through the Moody’s Manuals company by company, page by page (all ten thousand) comes from, and the famous quote,

I actually looked at every business– although I didn’t look very hard at some

In a similar vein, Warren’s classmates at the Columbia Business School completely ignored the opportunity they had, right in front of them, to learn investing from the premier guru of their era, Benjamin Graham. Instead,

They were a remarkably homogeneous group of men, mostly headed to General Motors, IBM or U.S. Steel after they got their degrees

These young men were being trained to become managers. Meanwhile, Buffett was training to become an owner (and he would later own IBM, while the other two American stalwarts died slow, painful deaths). Or, as Buffett later put it,

U.S. Steel was a good business… it was a big business, but they weren’t thinking about what kind of train they were getting on

Buffett also learned the importance of “swinging at the right pitches”:

You’re not supposed to bet every race. I’d committed the worst sin, which is that you get behind and you think you’ve got to break even that day

Simultaneously, Buffett was realizing the importance of thinking for oneself and not being a mindless trend follower. Granted an opportunity to play “the echo” to another trumpeter in the school band, Buffett found himself in a confusing and embarrassing situation in which the lead player played the wrong note and Warren didn’t know what to do as his “echo”. The lesson?

It might seem easier to go through life as the echo– but only until the other guy plays a wrong note

He also became enamored with Dale Carnegie and his social system, one of the most important lessons of which he felt was “Don’t criticize, condemn or complain.”

In addition, Buffett studied the biographies of great businessmen such as:

Jay Cooke

Daniel Drew

Jim Fisk

Cornelius Vanderbilt

Jay Gould

John D. Rockefeller

Andrew Carnegie

looking for the keys to their “system”.

History repeats itself, or at least rhymes

In Part II we also get a glimpse into the way that early themes and experiences in Buffett’s life replayed themselves as important investments in his later life as the world’s best known and must successful investor. For example:

as a child, Buffett sold chewing gum door-to-door; he later successfully invested in Wrigley’s chewing gum

as a child, Buffett collected soda bottle caps; he later successfully invested in Coca-Cola

as a child, Buffett was obsessed with model trains and always dreamed of owning a train set; he later successfully invested in Burlington Northern railroads

as a child, Buffett met Sidney Weinberg, an important figure at Goldman Sachs, during a field trip to Wall St with his father; he later successfully invested in Goldman Sachs

as a child, Buffett had a paper route in which he distributed, amongst many other papers, the Washington Post; he later successfully invested in the Washington Post and other dailies

Warren catches the wealth-bug

It was on his trip to the Stock Exchange in New York City in 1940 with his father that Warren first understood the money-making potential of stock investing. Witnessing exchange members who had servants roll custom cigars, Warren realized

the Stock Exchange must pour forth streams of money… he worked with a passion for the future he saw ahead of him, right there in sight. He wanted money

Later, Warren came across a book entitled “One Thousand Ways to Make $1,000” or, in Warren’s mind, how to make a million dollars. This was it. He was going to be a millionaire. The book had hopeful, helpful and optimistic advice that we would all well consider and pay attention to in the event that we become similarly motivated:

the opportunities of yesterday are as nothing compared with the opportunities that await the courageous, resourceful man of today! You cannot possibly succeed until you start. The way to begin making money is to begin… Hundreds of thousands of people in this country who would like to make a lot of money are not making it because they are waiting for this, that or the other to happen

Buffett also learned around this time the power of compounding and decided

If a dollar today was going to be worth ten some years from now, then in his mind the two were the same

Early Buffett investments, and why he made them

Before he had even graduated from college, the young Warren Buffett had made a number of stock and private investments:

Cities Service Preferred; bought three shares at $114.75 for himself and his sister, the shares fell and then recovered; Buffett sold at $40/share for a $5 profit, only to watch the shares rise to $202, lessons learned:

Do not overly fixate on the price paid for a stock

Don’t rush unthinkingly to grab a small profit; it can take years to earn back the profit “lost” through opportunity cost

Buffett didn’t want to have responsibility for other people’s money unless he was sure he could succeed

Around age 15, Warren had invested in “Builders Supply Co.”, a hardware store owned and operated by his father and his father’s business partner, Carl Falk, in Omaha

Around age 15, Warren bought a 40-acre farm for $1,200 that he split the profits of with a tenant farmer; he sold it when he was in college (5 years later) for $2,400

Buffett invested “sweat equity” in a paper route which earned him $175/mo in an era when a grown man felt well-paid on $3,000/yr

Buffett started a used golf-ball retailing business with a friend, selling golf balls for $6/dozen, through a wholesaler in Chicago named Witek

Buffett bought a pinball machine for $25, placed it in a barbershop and recouped $4 in the first day; he went on to purchase 7-8 pinball machines for “Mr. Wilson’s pinball machine company”, learning the principle of capital, money that works for its owner, as if it had a job of its own

1949, Buffett shorts automaker Kaiser-Frazer, which went from producing 1/20 cars to 1/100 in the market; Buffett saw a trend in the statistics

Preparing to enter Columbia, Buffett invested in Parkersburg Rig & Reel, purchasing 200 shares after discovering the company “according to Graham’s rules” in The Intelligent Investor

At Columbia, Buffett was invested in Tyer Rubber Company, Sargent & Co. and Marshell-Wells (a hardware company) of which he had jointly purchased 25 shares with his father; Marshell-Wells was the largest hardware wholesaler in the US and traded for $200 but earned $62/share, making it similar to a bond with a 31% yield

After visiting with Lou Simpson at GEICO, Buffett dumped 3/4ths of his stock portfolio to buy 350 shares of GEICO, which was trading at 8x current earnings at $42/share and was rapidly growing; Buffett felt his margin of safety was a growing, small company in a large field meaning it had a lot of opportunity ahead of it, especially because it was the lowest cost provider

Cleveland Worsted Mills, textile manufacturer selling for less than its current assets of $146/share; the company cut the dividend which was part of Buffett’s investment thesis and he sold the stock in disgust

A gas service station, which he bought with a friend for $2,000; the property never made money as they couldn’t entice customers from the nearby Texaco station; Buffett lost his investment and learned the value of customer habit

Related to the theme of early Buffett investments is the course of the young Buffett’s savings and the accumulation of his capital stock:

Age 14, his savings totaled around $1,000, “he was ahead of the game… getting ahead of the game, he knew, was the way to the goal”

Age 15, his savings totaled around $2,000, much of which was from his newspaper route

Age 16, his savings totaled around $5,000 ($53,000 in 2007 dollars), much of it from his pinball and golfball businesses

Age 20 (1950), his savings totaled $9,803.70 which was partly invested in stocks, as well as a $500 scholarship and $2,000 from his father for not smoking

Age 21, his savings totaled $19,738, he had boosted his capital 75% in a single year and he felt “supremely confident in his own investing abilities”, he also was willing to take on debt equal to a quarter of his net worth, or about $5,000, for total capital of around $25,000

Miscellaneous Buffett lessons

On betting and deal-making in general:

Know what the deal is in advance

What Buffett learned from Graham:

A stock is the right to own a little piece of a business

Use a margin of safety so the effects of good decisions are not wiped out by errors; the way to advance is to not retreat

Mr. Market is your servant, not your master

On influence:

it pays to hang around people better than you are, because you will float upward a little bit. And if you hang around with people that behave worse than you, pretty soon you’ll start sliding down the pole

Buffett’s authorship of the article “The Stock I Like Best” on GEICO attracted the attention of a later financial backer, Bill Rosenwald, son of Julius Rosenwald and longtime chairman of Sears, Roebuck & Co.